If F&O transactions are treated as speculative, then speculative business loss can only be set off against speculative business income

Can capital loss from futures and options (F&O) (i.e., business activity) be set off against interest from banks, interest from post office, rental income, or income from day trading in shares?

— Neeka Jain, e-mail

F&O transactions are treated as non-speculative business transactions as per the Income Tax (IT) Act, 1961, subject to fulfillment of certain conditions specified. Non-speculative business loss can be set off against any other income other than salary income. So F&O loss can be set off against interest from banks or post office and rental income. Non-speculative business loss can be set off against speculative business income but vice versa is not permissible. So F&O loss can also be set off against income from day trading in shares (speculative income).

If F&O transactions are treated as speculative, as conditions prescribed in the IT Act are not fulfilled, then speculative business loss can only be set off against speculative business income. So, in this case, F&O loss can be set off only against income from day trading (speculative income). It cannot be set off against interest or rental income.

As per Section 43(5)of the IT Act, trading in derivatives will not be treated as speculative business transaction if the transaction is carried out on a recognised stock exchange (BSE or NSE), and on screen-based systems, and supported by a time stamped contract note.

I trade in the cash segment of the BSE and the NSE daily. When shares bought are in profit, I sell them on the same day. Some times, I take delivery of shares and sell them after some time or the next day or even after one year. Now the question is: Is this business, speculative or both short-term and long-term capital gain as well as partial business trading and partial capital gain? And if this is treated as business, then, for audit, will the limit be the difference of the amount on daily basis? What will be the tax audit limit for delivery-based transactions? Can we treat both short-term and long-term capital gain and business trading in this case?

— Sunil Jethlia, e-mail

From your facts, it seems that your intention at the time of purchase of shares is to make quick profit. So if you make profit during the day, you sell it intraday or else the next day or later as and when profit is made. Hence, your share transactions are more likely to be treated as, ‘Business income'. Profit from intraday sales will be treated as speculative business income, whereas other transactions will be treated as non-speculative business income.

According to Section 44AB of the Income Tax (IT) Act, 1961, tax audit applies if turnover exceeds the limit of Rs 60 lakh from assessment year (AY) 2011-12 (up to AY 2010-11 it was Rs. 40 lakh).

For calculation of turnover for tax audit, the aggregate amount of positive and negative differences arising from dealing in such transactions is the turnover for speculative transactions. For non-speculative business, i.e., delivery-based transactions, the turnover is calculated as total amount of sales.

If you treat the transactions as business income as suggested, then for tax audit the limit will be considered both positive as well as negative differences for speculative intraday transactions. But for other (delivery-based) transactions, only sale proceeds will be considered to decide the limit for tax audit.

Apart from speculative transactions, which are covered under Section 43(5) of the IT Act, the investor has two portfolio options, i.e., he can hold the shares and securities as stock-in-trade or he can hold such shares and securities as investment (refer circular No. 4/2007, dated 15 June 2007, issued by the Central Board of Direct Taxes).

Also, the accounting treatment given by the assessee for such transactions will play an important role to decide if such activities are treated as investment or business activity. If an asset is held as stock-in-trade of the business, it is not a capital asset within the meaning of Section 2(14) of the IT Act. On the other hand, if the assessee held the asset as investment, the gain derived from transfer of asset shall be charged to tax under the head, ‘Capital gain'.

It is advisable to maintain separate demat accounts for trading stocks and investments so as to avoid any dispute subsequently.

My annual salary income is in the slab of 30%, interest income from Kisan Vikas Patra (KVP) Rs 70000, and loss from short-term inter-day delivery-based share transaction on which the securities transfer tax (STT) has been paid Rs 30000. All my transactions were done in September 2010. In addition, my short-term (six months) capital loss on sell transactions is Rs 60000. Can I treat the loss of Rs 30000 as business income and, thus, deduct from my interest income of Rs 70000? Can I treat Rs 60000 as short-term capital loss and carry forward it to next year? Am I to fill up income tax return (ITR-IV) form for this purpose? Can I use part of the Rs 60000 loss, i.e., Rs 40000, against my KVP income and carry-forward the rest to next year?

— Anup Chaudhuri, e-mail

From your facts it seems that you are not a regular trader but a mere investor. In our opinion, it would not be right to treat the short-term inter-day loss of Rs 30000 as business income just to claim benefit of set-off. According to Section 70 of the Income Tax (IT) Act, 1961, short-term capital loss can be set off against either long- term capital gain or short-term capital gain. It can be carried forward up to eight assessment years. Accordingly, you can carry forward the short-term capital loss of Rs 60000 to next year.

ITR-IV form is applicable to individuals and Hindu undivided families with income from a proprietary business or profession. This form is not applicable to you. You cannot set off the short-term capital loss against KVP interest income. KVP interest income is taxable under the head, ‘Income from other sources'. Short-term capital loss can be set off only against capital gain income.

I am salaried person. Presently, I fill up income tax return (ITR)-1 form. Recently, I opened a demat account and was allotted some shares in an initial public offers (IPO). If I sell these shares and pay the securities transaction tax (STT). Will I have to pay short-term capital gain tax? Should I continue to fill ITR-1? Or should I use some other form? If I sell the shares and pay STT after one year, long-term capital gain tax has to be paid. Do I continue to file my return though ITR-1 form?

— Shalini Agrawal, e-mail

ITR-1 is applicable to individuals with only salary and interest income. In case of salaried person, they must file ITR–1. But if a salaried person also has capital gain income, then, ITR–2 is to be filed. In ITR-2, short-term capital gain tax is to be shown under, ‘Capital gain' in the CG schedule.

If the assessee sells the shares and pay STT after a gap of one year, then long-term capital gain, which is exempted under Section 10(38) of the Income Tax Act, 1961, is to be shown under EI (exempt income) schedule.

In one of your previous columns you had explained the provisions of audit of accounts for a trader in the stock market. But I have one more question: who can be termed as a trader and investor? Is there any circular defining the two as profit or loss of a trader would be normal business and gain or loss for investor would be capital gain or loss?

— CA Gaurav Jain, e-mail

Demarcation is very thin between trader and investor. It is difficult to decide whether a given transaction is an adventure in the nature of trade or not. If a person invests money in land intending to hold it, enjoys its income for sometime, and then sells it at a profit, it would be a clear case of capital accretion and not profit derived from an adventure in the nature of trade. Cases of realisation of investments consisting of purchase and resale, though profitable, are clearly outside the domain of adventure in the nature of trade.

If an assessee carries on the business of buying and selling of securities like shares, debentures, bonds, units of mutual funds and derivatives and treats these securities as stock-in-trade, then the profit and gain from such business is chargeable under Section 28 of the Income Tax (IT) Act, 1961, under the head, ‘Profit and gain of business or profession' On the other hand, if an assessee invests and carries on buying and selling shares, units of mutual funds, bonds, debentures and derivatives, income from investment will be charged under the head, ‘Capital gain' under Section 45 of the IT Act. Refer the Central Board of Direct Taxes instruction no 1827, dated 31 August 1989, and also circular No. 4/2007 dated 15 June 2007. As per these circulars, the IT Act makes distinction between capital asset and trading asset. Capital asset is defined in Sections 2(14), 2(29A), 2(29B) and 2(42A) and 2(42B) of the IT Act, whereas trading asset is dealt with under Section 28 of the IT Act.

The substantial nature of transactions, the manner of maintaining the books of accounts, the magnitude of purchases and sales, the ratio between purchases and sales, and the holding period are good indicators to determine the nature of transaction. Ordinarily, purchase and sale of shares with the motive of earning profit would result in the transaction being in the nature of trade or adventure in the nature of trade. But if the object of investment in shares of a company is to derive income by way of dividend, then the profit accruing by chance in such investment will yield capital gain and not revenue receipt.

It is possible for a tax payer to have two portfolios (investment portfolio and trading portfolio). In such a case, the assessee may have income under, ‘Capital gain' and ‘Business income'.

Further, the assessing officers are advised that no single principle would be decisive and the total effect of all the principles should be considered to determine whether the shares are held by the assessee as investment or stock in trade.

The replies are only in the nature of guidelines. The tax counsellorsand the publication are not responsible for any decision taken by readers on the basis of the same. Readers may address their queries on direct taxation to:T K Doctor, C/o Capital Market, 101, Swastik Chambers, Sion-Trombay Road, Chembur, Mumbai-400 071.E-mail: tax-matters@capitalmarket.com